A Massive Writedown of U.S. Knowledge Capital

America’s economy isn’t a stalled car, nor is it an invalid who will soon return to health if he gets a bit more rest. Our problems are longer-term than either metaphor implies….The idea that the economic engine is going to catch or the patient rise from his sickbed any day now encourages policy makers to settle for sloppy, short-term measures when the economy really needs well-designed, sustained support.

So far, so good. But then Krugman goes off the rails:

The root of our current troubles lies in the debt American families ran up during the Bush-era housing bubble…What we’ve been dealing with ever since is a painful process of “deleveraging”: highly indebted Americans not only can’t spend the way they used to, they’re having to pay down the debts they ran up in the bubble years.

No, no, no. The build-up of debt was a symptom of the real underlying problem: A massive write-down of U.S. knowledge capital over the past 10-15 years, combined with anti-innovation policies on the part of the government.

U.S. prosperity has always depended far more on our accumulated store of knowledge capital than on our physical investments. Knowledge capital includes accumulated education, research and development, and business-knowhow–all the intangibles that underly a modern economy.

The value of knowledge capital depends, in part, on how rare it is. The more companies or countries that possess the same knowledge (say, about how to make a commercial airliner), the less valuable that knowledge is. This is just Economics 101, applied to intangibles.

Over the past 10-15 years, the strengthening of information flows into developing countries meant that knowledge capital was being distributed much more quickly around the world. As a result, the normal process of knowledge capital depreciation greatly accelerated in the U.S. and Europe–beneath the radar screen, because no statistical agency constructs a set of knowledge capital accounts.

What we should have been doing is boosting our investment in knowledge capital creation–education, R&D, business innovation. Instead, we borrowed to support consumption. Instead, we got Republican and Democratics administrations that were more concerned with punishing innovative industries and ladling on additional security and economic regulations.

We still have some major knowledge capital advantages–in communications, in the biosciences, in the rapidly growing area of digital education–that we can build on for the future. But this is the moment where we should be focusing on rebuilding our knowledge capital base rather than supporting debt-led consumption.

Added 12/15: Tyler Cowen agrees that knowledge capital may be depreciating more rapidly, but disagrees on the cause.

I agree with the conclusion but I am not sure that globalization was the mechanism. I sometimes think of an imaginary economy with two sectors: music and bathtubs. I believe that my bathtub is over thirty years old, yet for me it works fine and I have no desire to buy a new one. When it comes to music, most people want to listen to what is new and hot, not Bach’s B Minor Mass.

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I would read Krugman as debt interfering with making those long term changes, not with promoting further debt based consumption. Debt liquidation having gone from a symptom to a problem.

One of the problems with your position is, if knowledge capital is less of an advantage, and less capturable, why would we want to invest more into it rather than capturing the reverse flow as it is developed elsewhere, especially when it can be developed so much cheaper elsewhere, and where does the wherewithal come for this investment when it is delivering, and capable of delivering, so much less.

As someone who works in the software industry, this strikes me as a preposterous hypothesis. US players dominate the software industry. There are essentially no globally important players outside the US and the few exceptions (RIMM, NOK, SAP) are quickly losing their relevance to US competitors. I’d note that Software is probably the most “knowledge intensive” industry (and also one of the most profitable).

MSFT, GOOG, AMZN, APPL, ORCL, FLIX, EBAY, (soon-to-be FBOK or perhaps BOOK, as well as TWIT) represent +1T in almost pure knowledge capital, and those are just a handful of the largest software companies.

Google for some of the news articles talking about Silicon Valley in the late 80’s early 90’s about how chip manufacturing was moving to Taiwan & Korea and we were losing our “knowledge capital”. What was actually happening was US companies moving to more profitable areas, while foreign competitors were stuck with expensive commodity businesses (like memory chips & motherboards). It’s a continuing process and experts are always bemoaning the loss of one industry while other, more profitable (and knowledge capital-intensive) industry are quietly growing.

The U.S. software industry has been riding the communications boom, which as I noted is one of the few places where we still have a knowledge capital advantage. When I write about the communication innovation ecosystem, I always include Google, Facebook, anda Amazon.

So are you arguing this is a cause of the poor economic environment in the United States? While I can buy that, it certainly cannot be said that this “intellectual capital drain” was THE cause of the crash. If so, then we will be stuck in a state of permanent low growth, no? (unless we restructure our economy)

Policy Prescription: We should devote our resources to intangible and tangible investment, and encouraging innovative industries that are investing in knowledge capital, rather than supporting consumption and imports as we are currently doing.

I am an avid reader of your blog, but I really do not understand the series of posts over the past several weeks on the burdening of the economy with regulation. Most of this increase over the past decade as was posted elsewhere has to do with national security. Most people would argue that this is necessary, and I would assume the electorate would support this as well. Can you explain how expanding the Department of Homeland Security stifles innovation? Maybe there is some sort of connection, but to me it is not obvious. Without that growth, it seems to me that the expansion of the regulatory bodies is pretty reasonable.

On the other hand, something that we do not look at in the United States are counter-cyclical regulatory bodies and tax structures.

> Can you explain how expanding the Department of Homeland Security stifles innovation?

Sure. The telecom providers are currently being asked to open up gaping holes in their system in order to allow wiretaps. In essence, they are being pressured to slow down innovation to allow law enforcement to keep up.

I can go on and on, ranging from immigration to student visas to a general attitude that puts security over innovation.

I can agree with those examples (more the visa issue, because as a law student I have seen the effects of it), but are you postulating that the slow pre-crash growth rate was mostly due to effects like that? I can see those effecting a bit on the margin, but I would be hard-pressed to believe that this is the major drag of our economy right now.

I personally look at two things, but could be wrong: i) the increased focus on FIRE to provide returns, which has dangerously concentrated our economy; and ii) the massive debt overhang on the private sector, particularly for consumers and the low savings rate, which has massive repercussions in how individuals invest/spend/act, and will be cured only with time.

On your other points on the “knowledge-drain” I find those particularly interesting. I think part of that analysis has to lead one to “out-sourcing,” whereby many functional tasks in both services and manufacturing have been shipped abroad for short-term profits, thus exporting basic skills and know-how that have taken decades to develop.

This is definitely true, and I didn’t think of that. I graduated from college in ’06, and I knew a large group of foreign students who were not able to renew their visas, so returned to their homelands. Same now in law school with LLM students, who even if they wanted to stay, are stymied by both visa and other regulatory issues.

Seeing where the state of politics is presently, I sincerely doubt there will be much movement on this issue for the foreseeable future.

“Over the past 10-15 years, the strengthening of information flows into developing countries meant that knowledge capital was being distributed much more quickly around the world. As a result, the normal process of knowledge capital depreciation greatly accelerated in the U.S. and Europe

What we should have been doing is boosting our investment in knowledge capital creation–education, R&D, business innovation.”

The metaphor is of a country as container of “knowledge capital” that drains out and can be filled up. That makes sense when knowledge capital or what it was knowledge about can be appropriated. Where it can be digitized and, thanks to telecommunications, globally distributed as fast as it is created that metaphor is a less helpful way of thinking about economic development. Economic advantage can accrue to sharing knowledge capital not hoarding it. For example, creating a successful “platform” (hardware or software) requires distributing it and making it as easy as possible for it to be used even if it has to be given away. As economies shift more to “services” and information (“knowledge”) rather than stuff like ion ore it will become more difficult to leverage its economic value within a given country.

what KIND of regulation slows knowledge accumulation? Certainly not all regulation does this. Some regulation promotes innovation (eg the EPA regulations demonstrably increased patenting to make the air cleaner (see Veloso and Lee). Other regulation (eg minimum wages) makes it hard for non-innovating firms to stay in business (see Freeman, Davis, et al NBER working paper).

By my reading, the evidence in favor of induced innovation is weak. Besides, in this post I was mostly concerned with the global diffusion of knowledge lowering the market value of existing knowledge capital in the U.S, while the U.S. did not devote enough resources to creating new knowledge capital.

We all gain (at least eventually) from science and engineering down anywhere in the world. But there are advantages to being in the front. Essentially you have a short-term monopoly on the things and ideas you’ve just invented.

I think you’re using a ridiculously simple model in which all scientists and engineers produce a homogenous good called “innovation”, demand for which has remained constant, while supply has increased. Even under that simplistic model, your interpretation would require evidence of the relative effects involved, as the spread of scientific education reflects increases in the economic development of those countries, which presumably drives demand for “innovation”.

In any case, such a model represents a variant of the lump-of-labour fallacy – just as there is not a fixed amount of work to do, there is not a fixed amount “innovation” required. The effect of innovation is to increase the productive capacity of the economy, which is its value, and that is not affected by what foreigners are doing.

Imagine a simple world of two countries, Switzerland, and the UK. Switzerland has 12 Einsteins, who are creating lots of new physics-based goods (lasers, bombs, anti-gravity cars etc.). The UK has Alexander Fleming, inventing penicillin. Penicillin is just as valuable, whether or not Switzerland has a lot of new inventions. Indeed, the Swiss can afford to pay more for penicillin than they otherwise would, because of their super-productive physics-based economy.

The real problem is the unique way that talented and knowledgeable American citizen technical professionals are as I was quoted, “Thrown away like yesterday’s newspaper.” See “No Ph.D.s Need Apply” by Sharon Begley et.al. Newsweek, pp 62-63 05 December 1994 http://philip.greenspun.com/careers/no-phds-need-apply.text

This policy is the result of corrupt political processes where special economic interests lobbied in Washington, DC falsely alleging “looming shortages” of scientists and engineers. (This has never been the case in the U.S., but it is good P.R. cover for the campaign finance contributions – a.k.a. bribes – that trump reasoned arguments every day in our nation’s capitol.) One of the key actions was the passage of the obscure “Eilberg Amendment” in 1976 which allowed colleges and universities to import unlimited numbers of scientists and engineers to restrain salary growth. You may learn more by searching this phrase via Google. There were 236 links on 14 December 2010.

This policy is destroying the economic and military future of the United States like a cancer. You may learn more about the details by reading my 2005 article providing more details regarding the 1976 corruption, “Career Destruction Factories” at http://tinyurl.com/nn28sp. The follow on article, regarding the corruption of Microsoft Corporation, which hired lobbyist (and felon) Jack Abramoff to help procure 3 Microsoft-friendly changes to immigration law between 1995 and 2000. During this same period, Microsoft spent about $100 million on politically connected expenditures. My article is titled, “The Greedy Gates Immigration Gambit” at http://tinyurl.com/37l8ry

I think Mr. Mandel might be making too general of a case here. As commenter Lord said, it doesn’t make sense to invest in knowledge capital that can be easily shipped overseas. Manufacturing and engineering of physical products(e.g. cars, solar panels) can be quite easily be done in China; nothing about building a better or cheaper car or a better solar panel is disagreeable to political elites in China, so businesses are free and receive a great amount of state backing. Given that the output is tangible, companies that do that pose no great threat as rival sources of power, as the government could more or less appropriate all of the companies assets. However, companies whose main assets are organizational in nature, and I would include all of the internet superstars in this category, do pose a threat to Chinese government. Baidu will likely never compete with Google on the world market. Industries in which organizational capital is the key determinant of value creation is the place where the U.S. should focus investment on, because you can’t ship a culture overseas(unless you send massive waves of aggressive colonists/immigrants ala Europe and North America.)

Mandel is correct, and so is Krugman, but so are their critics! That is to say, each is partially correct, but none address the entire problem. We are in a transition to a Global Knowledge Economy, yet the term “knowledge” is bandied about without any very clear knowledge about what “knowledge” is about! Let me therefore offer a definition that is appropriate to the Knowledge Economy: Knowledge consists of concepts available to process information and guide action. Many of us are becoming, or have already become Knowledge Workers. But what most Knowledge Workers still lack is set of “skills in thinking” with which to perform competently. I summarize these “skills in thinking” with the term Knowledge Literacy. I have written 2 books on the topic [HOW TO THINK LIKE A KNOWLEDGE WORKER and HOW TO GET RESULTS IN KNOWLEDGE WORK – Google the titles], and also have commissioned a webiste devoted to the topic – http://www.knowledge-literacy.net – check it out!

Michael Mandel is chief economic strategist at the Progressive Policy Institute. He is also president of South Mountain Economics, and senior fellow at Wharton's Mack Center for Technological Innovation